]AE19- FINANCIAL MANAGEMENT

TIME VALUE OF MONEY

Money has a time value. Time value of money means that a peso today is worth more
than a peso

tomorrow.

If we have the option of receiving P10,000 today, or P10,000 a year from now, we will
choose to get the money now.

There are several reasons for our choice to get the money immediately.

First, we can use the money and spend it on basic human needs such as food and
shelter. If we already have enough money to survive, then we can use the P10,000 to
buy clothes, books, or transportation.

Second, we can invest the money that we receive today, and make it grow. If we do not
want to risk the money in stocks, we may buy riskless Treasury securities.

Third, there is a threat of inflation. There is a good possibility that a car selling for
P500,000 today may cost P600,000 next year. Thus, the P10,000 we receive a year from
now may not buy the same amount of goods and services that P10,000 can buy today.
We can avoid this erosion of the purchasing power of the dollar due to inflation if we can
receive the money today and spend it.

Fourth, human beings prefer to get pleasurable things as early as possible, and
postpone unpleasant things as much as possible. We can use the P10,000 that we
receive today buy new clothes, or to go out for dinner. If you are going to get the money
a year from now, you may also have to postpone all these nice things.

Then there is the uncertainty of not receiving the money at all after waiting for a year.
People are risk-averse, meaning, they do not like to take unnecessary risk. To avoid the
uncertainty, or the risk of non-payment, we would like to get the money as soon as
possible. Banks and thrift institutions know that to attract deposits from investors, they
must offer some kind of incentive. This incentive, the interest, compensates the
depositors for their unwillingness to spend their money immediately. For instance, if the
bank offers a 5% rate of interest to the depositors, the P10,000 today will become
P10,500 after a year.

Time value involves two major concepts: future value and present value.

KEY TERMS:
1) Future value of a single amount-- sometimes called compound value, which is the
amount to which a present amount of money or series of payments will grow over
time when compounded at a given interest rate. The factors affecting future value
are:
a) Principal- amount of money borrowed or invested today.
b) Interest-amount paid for (in case of borrowed money) or earned by (in case of
invested money) the use of money.
c) Time period- the length of tine or number of periods during which interest is paid
or earned.
 The value of peso today will increase in the future because of interest.
 2) Present value- -it is the current value of a future amount of money, or series of
payments, evaluated at an appropriate discount rate. A discount rate, sometimes
called the required rate of return, is the rate of interest that is used to find present
values. The process of determining the present value of a future amount is called
discounting.
3) Annuity- a series of equal-sized cash flows occurring over equal intervals of time.
An ordinary annuity exists when the cash flows occur at the end of each period. An
annuity due exists when the cash flows occur at the beginning of each period.
4) Future value of an ordinary annuity- the future value of a series of equal-sized
cash flow with the first payment taking place at the end of the first compounding
period. The last payment will not earn any interest since it is made at the end of the
annuity period.
5) Present value of an ordinary annuity- the present value of a series of equal-
sized cash flows with the first payment taking place at the end of the first
compounding period.
6) Future value of an annuity due - the future value of a series of equal-sized cash
flow with the first payment taking place at the beginning of the first compounding
period.
7) Present value of an annuity due - the present value of a series of equal-sized
cash flows with the first payment taking place at the beginning of the first
compounding period.
8) Perpetuity- an annuity with an indefinite life, that is, the payments continue
indefinitely. The present value of a perpetuity is computed by the following
equation:

PV of a perpetuity- Annuity/Discount rate

PROBLEMS:
1) ABC Corporation deposits its P100,000 for three years in a bank paying 2% annual interest. How
much will be the balance of the company’s deposit at the end of three years? (Ignore
withholding tax).

2) Compute the present value of P100,000 at a 10% annual interest rate at the end of one year, two
years and five years.

3) How long would it take to nearly double P100,000 at a 5% annual interest rate?

4) A finance manager has two options: 1) deposit P100,000 in a bank that pays 10% interest
annually, or (2) put the money In a bank that pays interest of 10% compounded semi-annually.
Determine the difference in the future value of the money under the two options.

5) ABC Company expects to receive P110,000 two years from now. What is the present value of this
amount if the discount rate is 10%?

6) As of Jan.1, 2024, ABC Company expects to receive payments of P100,000, P150,000 and
P200,000 at the end of 2024, 2025 and 2026, respectively. What is the present value of the
expected cash flows as of Jan.1, 2024 using 8% as discount rate?

7) ABC Corporation expects to receive P100,000 every December 31 for the next three years.
Compute the present value of the annuity at discount rate of 10%.

8) If you wish to accumulate P140,000 in 13 years, how much must you deposit today in an account
that pays an annual interest rate of 14%?

9) What will P247,000 grow to be in 9 years if it is invested today in an account with an annual
interest rate of 11%?
10) How many years will it take for P136,000 to grow to be P466,000 if it is invested in an account
with an annual interest rate of 8%?

11) Which of the following statements is true?

Statement 1: The future value of a lump sum and the future value of an annuity will both
increase as you
Increase the interest rate.
Statement 2: As you increase the length of time from now until the time of receipt of a lump sum,
the
present value of the lump sum increases.
Statement 3: The present value of a lump sum to be received at some point in the future
decreases as
you increase the interest rate, but the present value of an annuity increases as you
increase the interest rate.

a) Statement 1 only d) Statements 1 and 2

b) Statement 2 only e) Statements 1 and 3
c) Statement 3 only f) Statements 2 and 3

12) Which of the following investments would have the highest future value at the end of 10 years?
Assume that the annual interest rate for all investments is the same and is greater than zero.
a) Investment A pays P250 at the beginning of every year for the next 10 years (a total of 10
payments)
b) Investment B pays P125 at the end of every 6 months for the next 10 years (a total of 20
payments)
c) Investment C pays P125 at the beginning of every 6 months for the next 10 years (a total of
20 payments)
d) Investment D pays P2,500 at the end of the tenth year
e) Investment E pays P250 at the end of every year (a total of 10 payments)

13) The present value of P300,000 to be received in 5 years at 10% discount rate is P200,000. True
or False?

14) True or False: If the discount rate is positive, the future value of an expected series of payments
will always exceed the present value.

15) Which of the following statements is correct?

a) The cash flows of an annuity due occur at the end of each period.
b) If a series of unequal cash flows occurs at regular intervals, such as once a year, then the
series is by definition an annuity.
c) The cash flows for an ordinary annuity remain constant from period to period and they occur
at the end of each period.
d) If a series of equal cash flows occurs at regular intervals, such as once per year, then the
series is not an annuity.

16) By increasing the number of compounding periods in a year, while holding the stated annual
interest rate constant, the result will be:
a) Decrease the effective annual rate
b) Increase the effective annual rate
c) Not change the effective annual rate
d) There is not enough information to answer the question
e) Increase the peso return on an investment but will decrease the effective rate

17) Calculate the present value of the following uneven stream of cash flows. Assume a discount
rate of 8%.
End of Year Cash Flow
1 P100,000
2 110,000
3 120,000
 4 130,000
5 140,000
6 150,000

18) ABC Realty is considering selling an apartment property that it owns. A buyer is willing to pay
P2.0M for the property, all of which would be paid to ABC Realty upfront. Determine what ABC
Realty should decide under the following scenarios:
a) ABC expects the property to generate a cash inflow of P150,000 every year, forever, with the
first cash inflow occurring one year from today. The applicable discount rate is 10%.
b) ABC expects the property to generate P150,000 one year from today, and this amount will
grow by approximately 3% every year thereafter, forever. The applicable discount rate is
10%.

19) ABC Company has steadily increased its dividends per share from P1.00 in 2019 to P1.36 in 2023.
Compute for the annual compound growth rate of the dividends.

20) How much should you deposit in a bank that will allow you to withdraw the amount of P10,000 at
the end of each year without reducing the amount of the initial deposit? Assume the bank pays
an annual interest rate of 2.5%.

21) You decide to put P12,000 in a money market fund that pays interest at the annual rate of 8.4%,
compounding it monthly. You plan to take the money out after one year and pay the income tax
on the interest earned. You are in the 20% tax bracket. Find the total amount available to you
after taxes.
22) Your employer has promised to give you a P5,000 bonus after you have been working for him for
5 years. What is the present value of this bonus if the proper discount rate is 8%?
23) Discount rate and Inflation rate:
ABC Company has recently installed a large utility scale PV power-plant. The overall plant cost is
P100M and the plant is operational. There are dozens of large inverters as a part of the system,
which will need to be replaced in about 7 years. If there are 20 inverters, which cost P20,000
each, how much cash does the company need to have now, invested at discount rate of 6%, in
order to purchase the inverters in 7 years? Assume an inflation rate of 3%.
Note: Determine the Present Worth, which is the amount of money needed at the present
(invested at discount rate), in order to purchase something in the future (with an inflation rate of
____).
24) Multiple choice questions:
1) The future value of P1,100, compounding at the rate of 6% annually, after 10 years, is:
a) P1,600 b) P1,819.40 c) P1,790.85 d) P1,969.93

2) The present value of P5,000 that you will get after 10 years, discounted at the rate of 5%,
is:
a) P2,508.91 b) P2,965.34 c) P2,899.77 d) P3,069.57

3) The monthly interest rate on a savings account is 1%, compounded monthly. The
effective annual rate is:
a) 11.25% b) 12.68% c) 12.0% d) 13.13%

4) If the discount rate is 7%, then the present value of P40,000 that you expect to get after
15 years is:
a) P14,497.84 b) P106,400.80 c) P15,037.48 d) 110,361.26

5) The future value of P10,000 after 11 years, growing at the rate of 12% per year, is:
a) P34,237.40 b) P34,785.50 c) P34,522.71 d) P34,984.51i